The Right Kind of Alpha
Exploring the bidirectional nature of frameworks to uncover alpha in all areas of life.
When I began investing, "alpha" was a foreign term to me.
The only time I'd heard the word before was 20 years prior when I had to memorize the Greek alphabet for my fraternity. But after four years of diving into individual stocks, I've grown quite acquainted with the concept.
Alpha, simply put, signifies the difference an investor earns above their benchmark.
Investors use various benchmarks, so for our discussion, let's consider the S&P 500. If the S&P returns 10% in 2024, anything exceeding 10% constitutes my alpha. Achieving an 11% gain in my stock portfolio for 2024 translates to 1 point of alpha. This might not seem significant initially, but compounded over 30 years, even a single point of alpha can yield substantial results.
While one point of alpha might sound achievable, the reality is that most investors struggle to generate consistent alpha over time, and I am not immune.
I can confidently say I belong in the group that struggles to earn alpha. Don't feel bad for me. Chances are you're in that group too. Beating the market is hard to do, and most fare better by placing their funds in an index and calling it a day.
In truth, the majority of my investments are in an index for this very reason.
So, why am I even talking about alpha?
The reason is simple: I believe investors can earn two kinds of alpha, and I'm after both.
I didn't always believe this. I used to think investing was separate from the rest of my life, but a few years ago, I listened to a podcast that forever altered my perspective.
If you have dug through the Mastering Your Money archives or scrolled through my Twitter feed, you already know that I am a huge fan of Motley Fool cofounder, David Gardner, and have listened to every episode of the Rule Breaker Investing Podcast (David is the host).
Side note and not-so-humble brag ... I recently appeared on an episode, but that's a story for another day.
I digress. Let's get back on track.
In 2017, David discussed a framework created by Deborah Meier called the 5 Habits of Mind. The framework was used by Deborah during her career in education. In less than 28 minutes, David reframed it into a tool to discover great businesses.
I was blown away. David seamlessly connected two different industries with a single framework and made it look effortless. The reality is he's been honing this skill for years, and that's why it appeared so easy. It's called associative thinking, and while not a new concept, I've realized the best investors excel at it.
Associative thinking boils down to adopting a framework or idea from one area and applying it to a different one. While I was familiar with the concept, something clicked for me that day when I heard David use it on his podcast.
It felt a lot like the day I drove off the lot in my red Toyota Tacoma for the first time.
I was thrilled to find a red truck because it's my favorite color, and I'd never spotted one on the road. Until...
I drove off the lot and began noticing red Tacomas everywhere. Now that my mind was attuned to it, I couldn't stop seeing them. This phenomenon is commonly known as the Baader-Meinhof phenomenon or the frequency illusion.
Just like the red truck, these frameworks have always been around, but now, thanks to David's podcast, my eye is trained to perceive them differently. Understanding their bidirectional nature has led to some fascinating experiments. Now, anytime I learn a new concept, framework, or mental model, I consider how it can apply to my investing journey.
And it works both ways. We can take frameworks from investing and apply them to other areas.
This realization has prompted me to embark on a new project. Over the past few years, I've forged invaluable connections with remarkable investors. While their market performance is impressive, what draws me to them is their ability to achieve alpha in multiple ways.
These are just a few of the characteristics I've noticed in them:
They are humble.
They build others up.
They are always learning.
They are constantly curious.
They give more than they get.
They don't speak in absolutes.
They've leveraged investing lessons to generate alpha not just in investing but in life as well. The best way I know to sum it up is with a Warren Buffett quote:
“I am a better investor because I am a businessman, and a better businessman because I am an investor.” - Warren Buffett
Because investing touches so many areas of life, I believe the word ‘businessman’ can be substituted with … husband, father, son, daughter, friend, coworker, neighbor … the list goes on and on.
My goal over the next year is to tap into my network and conduct a series of interviews. I want to dive deep into the bidirectional nature of frameworks and see how we might improve as investors and humans.
Over the next few weeks, I'll be finalizing my questions and sending out interview requests. In addition, I'll explore frameworks and concepts and share my learnings along the way.
While uncertain about where this project will lead, I'm excited to see what unfolds. As we study and learn together, I believe each week will contribute to something bigger than we can currently imagine. In a year or two, we'll look back and appreciate the journey's growth and unexpected rewards.
That's called compounding, and it's the reason I think it's time to get started.
If this resonates with you, please subscribe and share with a friend. Join me on this journey to discover how we can all generate alpha in the stock market and beyond.
Outstanding!